Traders sometimes channel a little help from the past's great technicians. Some of those gurus are still with us, such as John Bollinger, inventor of Bollinger bands or envelopes. Others, such as Chester Keltner, who first described Keltner channels, and Richard Donchian, credited as the inventor of Donchian channels, are gone. Although I remember studying regression analysis way back when, I have no idea who first pioneered studies in regression analysis or applied regression analysis to studying the markets. Whoever it was must also be included in those whose help traders sometimes channel.
All are responsible for channels or bands that help traders pinpoint likely resistance and support. My recent articles have promoted the importance of determining resistance and support for all options traders, no matter what type of options plays they might employ. Those of us trading credit spreads count on prices not violating our sold strikes. Those buying calls or puts count on prices moving up from support or down from resistance. Whatever we're doing as options traders, we need tools to determine where support or resistance are likely to be found. Previous articles have discussed using moving averages and trendlines. This one touches on several types of channels or bands.
Most traders are familiar with regression channels and Bollinger bands. If not, sources such as www.stockcharts.com's "Chart School" discuss Bollinger bands or various types of envelopes or price channels. Fewer discussions can be found on Donchian or Keltner channels, so I thought I'd concentrate on those in this article.
Traders should become familiar with Donchian channels because those channels provide a quick and easy-to-read snapshot of historical support or resistance over any period of time traders input. Suppose that at the end of the day on August 30, traders had wanted to know where support and resistance had been found on the last 20 fifteen-minute periods on the SPX, for example.
Annotated 15-Minute Donchian Chart for the SPX:
Donchian channels were intended to identify breakout plays. Because they are set at the highest and lowest value for any predetermined number of bars, the channels will always move up or down with resistance or support. When I want to identify a breakout, I offset them by two periods, but when I want a quick reference for resistance or support, I do not use an offset. A glance across the screen tells me where historical resistance or support has been found without a lot of extra effort or time.
The chart can provide other information. On the Donchian channel chart of the SPX seen above, the channel lines have moved around a bit. That movement alerts traders neither support nor resistance were particularly stable over the period being examined, a useful bit of information. On August 31, the SPX was to break through the resistance shown above, rising for a few days before it broke lower again. Although the direction of that initial upside breakout wasn't apparent, the steeply rising support had been, and the volatility of both support and resistance had been changing.
While Donchian channels are useful in pinpointing historical support or resistance, Keltner channels help identify future support and resistance. They go further, helping traders set targets if that support or resistance is breached.
Annotated 240-Minute Keltner Channels for the RUT:
For most indices, the black channel lines contain most price movements on 240-minute and daily charts, and often on the intraday ones, too. Ultimately, they did on the RUT, too, with the RUT finally beginning its long slide lower this week. I set these black channel lines using a 45-ema (length = 9) and a multiplier of 3.
Those studying Keltner channels should remember that the lines are dynamic, with price movements either nudging or shoving those channel lines in the direction they're moving. Whether they're nudged or shoved depends on the momentum of the price movement, but they won't stay static unless price is relatively static, too. The RUT was to nudge its black resistance line a little higher in the days following the initial capture of the chart seen above, but only one 240-minute close was above that line, and that was only by a few cents, a stop-running movement before the next candle started the decline.
Even if the lines can be nudged or shoved by price movements, they're helpful for determining likely support or resistance over a given period of time. When planning options plays to be held for a number of days up to a couple of weeks, the 240-minute and daily charts prove helpful. If plays will unfold over a number of weeks, the weekly Keltner chart should also be consulted.
Day trades require study of intraday charts, with three-minute, five-minute, seven-minute and fifteen-minute charts often helpful, depending on the security being studied.
Annotated Seven-Minute Keltner Chart of the OEX:
At the same time that the OEX was adhering rather well to the resistance implied by the outer Keltner channel on the seven-minute chart, the Russell 2000 required a study of the 60-minute chart before reliable Keltner support and resistance could be found. Each security differs slightly except on those days when buy and sell programs are impacting most indices equally. Then you'll find them moving in lockstep, but most times, you'll need to do a little investigation. It's not hard and it doesn't take long to flip through several charts with several different time intervals.
To summarize, Donchian channels pinpoint historical support and resistance, while Keltner channels, by contrast, provide a sense of where next support or resistance might be found. Nesting several Keltner channels together, such as the 45-ema/3-multiplier and 120-ema/7.2-multiplier channels seen here, go further by telling traders where prices might go if the primary support or resistance is breached on a close.
Similarly, regression channels determine trendlines where support or resistance has historically been found on a trending move. I would compare Bollinger bands to Keltner channels, in that they show where support or resistance is likely to be found, not where it was found historically.
Both historical and likely support and resistance are important to know, so in swing or position trades that allow one to study charts for a time and not act on a hair-trigger decision, I would recommend studying one type of channel that determines historical support or resistance and another that determines likely next support or resistance. Examples might include studying both regression channels and Keltner channels or both Donchian channels and Bollinger bands, or any similar combination. If day trading and not able to study more than one chart, I prefer nested Keltner charts, but many other traders stick by Bollinger bands. Spend a quiet market day studying the various types available to you on your charting service, and make your own decision, but do channel a little help from the past's great trading gurus.